FAR - Becker F6 Flashcards
Defined benefit plans are:
Benefits that the employee receives at retirement are determined by formula.
It is the sponsor company’s responsibility to ensure that contributions to the plan are sufficient to pay benefits as they come due
(Complex accounting)
Requires multiple journal entries
Defined contribution plans are:
Contributions that the sponsor company makes to the plan are determined by formula.
The employees’ retirement benefits are based on the amount of funds in the plan
(Simple accounting)
Require only 1 journal entry
Pension plans and sponsoring company are 2 separate legal entities? T/F?
True
Each requires their own financial statements
Accounting for pension plans is concerned primarily with determining the amount of:
1) pension expense that appears on the sponsor company’s income statement
2) any related pension accounts (asset, liability, and/or OCI accounts) that appear on the sponsor company’s balance sheet
Pension accounting is concerned with:
Amounts accrued and expenses by the employer company and the funded status of the plan
Based on accrual accounting
Characteristics of pension plans include:
- Written or implied
- Contributory and noncontributory
- Funded or nonfunded
- Over funded vs underfunded
Types of pension plans NON GAAP
Non US GAAP:
1) pay as you go - a cash basis method of expensing pension plan payments after someone has retired
2) terminal funding - a company pays an entire pension plan liability upon retirement of an employee, generally by purchasing an annuity-type insurance policy.
Types of pension plans US GAAP:
1) Defined contribution plan -specifies the periodic amount of contributions to the plan and the way the contribution should be allocated to employees
Example: 401K plan
- types of factors considered when calculating contributions to the plan include:
1) employees length of service
2) compensation amount
2) Defined benefit plan - defines the benefits to be paid to employees at retirement. Contribution are computed using actuarial assumptions of future benefit payments based on factors such as:
1) employees compensation levels at or near retirement
2) the number of years of employee service
3) the number of years into employee retires
4) the number of years the plan expect to pay benefits after and a pulley retires
Accumulated benefit obligation (ABO) is:
The actuarial present value of benefits attributed by a formula based on current and past compensation levels. An ABO differs from a PBO only in that the ABO includes no assumption about future compensation levels
(uses current salaries)
Projected benefit obligation (PBO) is:
The actuarial present value of all benefits attributed by the plan’s benefit formula to employee services rendered prior to that date. PBO only uses an assumption as to future compensation levels
( use (guess) future salary)
Under IFRS, the defined-benefit obligation (DBO) is:
Defined benefit pension plan liability
The DBO (IFRS) and the PBO (GAAP) are calculated in a similar manner
Pension plan service cost is:
The present value of all pension benefits earned by company employees in the current year. It is provided by the actuary.
The service cost component increases the projected benefit obligation
Interest cost always increases the PBO because the present value of any liability increases as you get closer to the due date? T/F?
True
Pension plan prior service costs are:
The cost of benefits based on past service granted for:
- Service prior to the initiation of a pension plan that employees retroactively receive credit for when the plan is implemented
- Subsequent plan amendment , reflecting new or increased benefits, that also is applied to service already provided.
Prior service cost increases the PBO in the period of the plan initiation or admitted and should be:
Should be amortized to pension expense over the future service periods of the affected employees
A pension plan is :
An agreement in which the employer provides employees with defined or estimated retirement benefits in exchange for current or past services
- not paid currently
- paid to retired employees
- deferred compensation
What are actuarial gains and losses?
Actuarial gains and losses are adjustments to the projected benefit obligation that arise when the actuary changes one or more of the assumptions used to calculate the PPO.
Actuarial gains decrease the PPO
actuarial losses increase the PPO
The payment of pension benefits reduces:
Reduces the projected benefit obligation and reduces plan assets
Formula to calculate the PBO:
Beginning PBO
+ Service cost
+ Interest cost
+ Prior service cost from current plan amends
+ Actuarial losses incurred in the current per.
- Actuarial gains incurred in the current per
- Benefits paid to retirees
= Ending PBO
Formula used to calculate the ending fair value of plan assets:
Beginning fair value of plan assets \+ Contributions \+ Actual return on plan assets - Benefits paid to retirees = Ending fair value of plan assets
Actual return on plan assets can be a “squeeze”
Under US GAAP, pension expense (Also known as “Net periodic pension costs”) is the increase in:
the PBO during the period, offset by earnings on plan assets, and adjusted for the effects of certain smoothing mechanisms
Income statement expense formula for net pension expense under US GAAP:
Mnemonics SIRAGE
SIR - Are going to be absolute expenses of the current.
AGE - are income smoothing items. These items were put into accumulated other comprehensive income and then we bleed them out
Current service cost \+ interest cost - Return on plan assets \+ Amortization of prior service cost - Gains and + losses \+ Amortization of existing net obligation or net assets = Net periodic pension costs
Under US GAAP, all the components of net periodic pension costs must be aggregated and presented as one amount on the income statement. However, this is not true for IFRS:
IFRS allows components of defined benefit costs to report separately on the income statement
Journal entry to record net periodic pension costs:
DR: net periodic pension costs
CR: pension benefit liability
CR: OCI
Journal entry to pay net periodic pension costs:
DR: pension benefit liability
CR: cash
SIRAGE mnemonics =
For net periodic pension expense
Income statement accounting
S - current service cost
I - interest cost
R - return on plan assets
A - amortization of unrecognized prior service cost
G - gains and losses
E - amortization of existing net obligation or net assets
S - current service costs:
The present value of all benefits earned in the current period. In other words, the increase in the PBO resulting from employee services in the current period. The pension benefit formula is applied to compute a present value. The actuary provide service costs
I - interest costs:
the increase in the PBO during the current period that is due to the passage of time
Beginning of period PBO x discount rate
R - return on plan assets:
1) actual return on plan assets
2) expect a return on plan assets
Formula = beginning FV plan assets x expected rate of return on plan assets
NOTE: when companies who used to be expected return on plan assets to calculate pinch and experience, the difference between actual and expect a return must be recognized in OCI each period and then amortized to pension expense overtime with any actuarial gains or losses
A - amortization of unrecognized prior service cost:
Under US GAAP, and the period that a pension plan is initiated or amended, the resulting prior service cause increases the PBO and is recorded as unrecognized prior service costs in OCI
Unrecognized prior service cost in AOCI is amortized to pension expense over the plan participant’s remaining years of service.
The amortization is calculated using the unrecognized prior service cost balance at the beginning of the period
Formula: beginning unrecognized prior service cost ÷ Average remaining service life
G - gains and losses:
Gains and losses arise from two sources:
1) The difference between the expected and actual return on plan assets when the expected return on plan asset is used to calculate pension expense
2) changes in actuarial assumptions
Note: if something is considered good for the plan then it is a GAIN
if something is considered bad for the plan then it is a LOSS
Note: can recognize gain now or use Corridor Approach
The corridor approach:
an entity’s net unrecognized gain or loss is amortized over the employees average remaining service period, And as of the beginning of the year,
this amount exceeds 10% of the greater the beginning of the year balance of:
1) market related value of plan assets = assets
2) PBO = liabilities
Formula:
Unrecognized gain or loss
-(greater of) 10%of Beg PBO or Beg FV market related value
= Excess
÷ Average remaining service life
= Amortization of unrecognized gain or loss
E - amortization of existing net obligation or net asset at implementation:
This funding status was required to be amortized over the greater of 15 years or the average remaining job life of the company’s employees
Formula: PBO - Fair value plan assets = initial unfunded obligation ÷ (greater of) 15 years or average employee job life = Minimum amortization
Pension plan funding journal entry:
(Balance sheet accounting)
Company J/E
DR - pension benefit asset/liability
CR - cash
Funded status: (balance sheet accounting)
Under US GAAP, companies must report the funded status of their pension plans on the balance sheet as an asset or a liability (or both)
The funded status of a pension plan is calculated using the formula:
Fair value of plan
- PBO
= funded status
1) Pension plan asset – A positive funded status indicates that the pension is overfunded (fair value of plan assets > PBO). For balance sheet reporting purposes, all overfunded pension plans are aggregated and reported in total as a non-current asset (always)
2) pension plan liability – a negative funded status (fair value plan assets
Prior service cost and pension losses decrease the funded status of the pension plan and are recorded with the following journal entry in the period incurred:
DR - OCI. (Goes to AOCI)
CR - pension benefit asset/liability
Note: a deferred tax asset may also be recognize
DR - deferred tax asset
CR - deferred tax benefit – OCI
Amortization to pension expense J/E: for losses
When prior service cause, pension losses, and any remaining transition obligation or amortized, they are reclassified out of AOCI and recognized as a component of pension expense
DR – net periodic pension cost
CR – OCI
Deferred tax benefit
DR - Deferred tax benefit - OCI
CR - deferred tax benefit - income statement
Pension gains recognition journal entry:
Pension gain increased the funded status of the pension plan and are recorded with the following journal entry in the period incurred:
DR – pension benefit asset/liability
CR – OCI
Deferred tax liability
DR – deferred tax expense – OCI
CR – deferred tax liability
Amortization to pension expense: Gains J/E:
When pension gains and any remaining net transition assets are recognized in net periodic pension costs through the amortization process, the following journal entry adjustment is recorded
DR – OCI
CR – net periodic pension costs
Deferred tax expense
DR – deferred tax expense – income statement
CR - deferred tax expense – OCI
Pension gains recognition journal entry:
Pension gain increased the funded status of the pension plan and are recorded with the following journal entry in the period incurred:
DR – pension benefit asset/liability
CR – OCI
Deferred tax liability
DR – deferred tax expense – OCI
CR – deferred tax liability
Amortization to pension expense: Gains J/E:
When pension gains and any remaining net transition assets are recognized in net periodic pension costs through the amortization process, the following journal entry adjustment is recorded
DR – OCI
CR – net periodic pension costs
Deferred tax expense
DR – deferred tax expense – income statement
CR - deferred tax expense – OCI
US GAAP requires that the measurement date of the plan assets and benefit obligations of a defined benefit pension plan must be aligned with the date of the employer’s:
Balance sheet, with a few exceptions:
1) when a plan is sponsored by a subsidiary that has a different fiscal year end from the parent company, then the subsidiary’s plan assets and benefit obligations can be measured as of the subsidiary’s balance sheet day
2) when a plan is sponsored by an equity method investee that has a different fiscal year end from the investors fiscal year end, then the investee’s plan assets and benefit obligations can be measured as of the date of the investee’s financial statements used to apply equity method
